Recap Week 4
FINS 5550 / FINS 3650 — International Banking
Recap 04A — Credit Transformation and Credit Risk
Credit Risk More than eighty percent of the average bank’s capital is held against credit risk. If credit risk accounts for >80% of the bank’s inventory cost, it’s a fair bet that credit transformation accounts for a similarly large portion of bank profits. Credit risk arises whenever the bank has an exposure which requires a counterparty to remit funds. The exposure can arise from a loan or loan-type product derived from a given origination channel (direct solicitation, agent solicitation, brokered, or reverse inquiry). [Please read the S&P primer(s) on syndicated loans, posted on Blackboard.] The exposure also can arise from a contingency such as a line of credit [What’s the difference between a line of credit and a revolving line of credit?], letter of credit [What’s the difference between a letter of credit and a line of credit?], or performance bond. Alternatively, the exposure can arise from a swap exposure. [Describe an example of when a bank has an exposure due to an interest-rate swap. How does one quantify the exposure?] While this recap generally refers to the exposure as a loan, the form of the exposure doesn’t really matter. What does matter is the likelihood that the exposure will be repaid. Traditional Underwriting Traditional banking calls for each exposure — actual or potential — to be individually underwritten — a process which demands time, effort, and expertise. Many discussions of credit underwriting begin with the so-called Four Cs of underwriting (see Dun & Bradstreet’s take at http://smallbusiness.dnb.com/business-finance/business-loansbusiness-credit/12154-1.html, or a longer laundry list at http://www.creditguru.com). Not everyone agrees what constitutes the Four Cs, and what is indisputable is that more than four aspects should be taken into account: The Five Original Four Cs Character — D&B lists a number of factors, mostly speaking to the
Recap 04A — Credit Transformation and Credit Risk
Credit Risk More than eighty percent of the average bank’s capital is held against credit risk. If credit risk accounts for >80% of the bank’s inventory cost, it’s a fair bet that credit transformation accounts for a similarly large portion of bank profits. Credit risk arises whenever the bank has an exposure which requires a counterparty to remit funds. The exposure can arise from a loan or loan-type product derived from a given origination channel (direct solicitation, agent solicitation, brokered, or reverse inquiry). [Please read the S&P primer(s) on syndicated loans, posted on Blackboard.] The exposure also can arise from a contingency such as a line of credit [What’s the difference between a line of credit and a revolving line of credit?], letter of credit [What’s the difference between a letter of credit and a line of credit?], or performance bond. Alternatively, the exposure can arise from a swap exposure. [Describe an example of when a bank has an exposure due to an interest-rate swap. How does one quantify the exposure?] While this recap generally refers to the exposure as a loan, the form of the exposure doesn’t really matter. What does matter is the likelihood that the exposure will be repaid. Traditional Underwriting Traditional banking calls for each exposure — actual or potential — to be individually underwritten — a process which demands time, effort, and expertise. Many discussions of credit underwriting begin with the so-called Four Cs of underwriting (see Dun & Bradstreet’s take at http://smallbusiness.dnb.com/business-finance/business-loansbusiness-credit/12154-1.html, or a longer laundry list at http://www.creditguru.com). Not everyone agrees what constitutes the Four Cs, and what is indisputable is that more than four aspects should be taken into account: The Five Original Four Cs Character — D&B lists a number of factors, mostly speaking to the